Repurchase Agreements (Repos) – Derivatives & Repo Reporthttps://www.derivativesandreporeport.com
A Buy-Side Guide to Regulatory and Transactional Issues Related To Derivatives and Repurchase AgreementsThu, 14 Feb 2019 21:34:13 +0000en-UShourly1https://wordpress.org/?v=4.9.102019 Priorities: Reg SHO/Short Sellinghttps://www.derivativesandreporeport.com/2019/02/2019-priorities-reg-sho-short-selling/
Fri, 01 Feb 2019 19:16:34 +0000https://www.derivativesandreporeport.com/?p=2918Continue Reading]]>Both the SEC and FINRA recently released their 2019 Examination priorities, (available here and here) highlighting primary areas of focus for 2019. While there are no surprises, there are some items that have a unique twist that warrant attention. In this post we provide an overview of the regulators focus on Reg SHO and short selling.

Both regulators will continue to focus on aspects of Reg SHO compliance. FINRA will be focused on the exception to the netting required in Rule 200(c). Rule 200(c) states that a person shall be deemed to own securities only to the extent that he has a net long position in such securities. Rule 200(f) grants an exception to the netting requirement by allowing broker-dealers to break into independent aggregation units for purposes of determining the trading unit’s net position. To take advantage of the exception, broker-dealers must demonstrate four criteria to establish separateness and independence. Of note, only broker-dealers can rely on 200(f). During the adoption of Reg SHO Rule 200, commenters requested that the SEC extend the relief beyond broker-dealers, and the SEC declined to do so, stating that the lack of oversight by a self-regulatory organization might facilitate the creation of units that are not truly independent or separate. The SEC will be looking at Reg SHO compliance more broadly in the context of microcap securities.

FINRA is also focused on Exchange Act Rule 14e-4, the short tender rule. Specifically, FINRA will be reviewing how firms account for their options positions when tendering shares in the offer. Of note, a firm should carefully review the language of Rule 14e-4 and calculate its net position consistent with the rules requirements. There have been some firms that have attempted to use their net position calculation in the Reg SHO context for Rule 14e-4 compliance. The net position calculations are different and often lead to different outcomes.

Good Day DR2

]]>SEC Chairman Weighs in on the Transition to SOFRhttps://www.derivativesandreporeport.com/2018/12/sec-chairman-weighs-in-on-the-transition-to-sofr/
Tue, 11 Dec 2018 17:00:32 +0000https://www.derivativesandreporeport.com/?p=2896Continue Reading]]>On the heels of remarks by his U.S. Commodity Futures Trading Commission (“CFTC”) counterpart, U.S. Securities and Exchange Commission (“SEC”) Chairman Jay Clayton recently commented on ongoing benchmark reform and the transition to the Secured Overnight Financing Rate (“SOFR”). As we noted earlier this week, Chairman J. Christopher Giancarlo of the CFTC recently advocated for the adoption of SOFR as the appropriate replacement for LIBOR and added that the CFTC is already working on the transition. He implored market participants and firms to immediately begin transacting in SOFR derivatives for the health of the transition.

In remarks on December 6, 2018, Chairman Clayton mentioned the transition away from LIBOR as a market risk that the SEC is currently monitoring. For Chairman Clayton, the key risk stems from the fact that there are approximately $200 trillion in notional transactions referencing the U.S. Dollar LIBOR and that more than $35 trillion will not mature by the end of 2021, when banks currently reporting information used to set LIBOR are scheduled to stop doing so. Listing potential issues with a transition away from LIBOR, Chairman Clayton raised questions such as what happens to the interest rates of the instruments that will not mature before 2021 but reference LIBOR? Does an instrument’s documentation include any fallback language? If not, will consents be required to amend the documentation?

Despite his concerns, Chairman Clayton also spoke positively of SOFR as an alternative benchmark for LIBOR. For instance, because SOFR is based on direct observable transactions (i.e., transactions in the repurchase agreement transaction (“repo”) markets), its underlying markets have deep liquidity (e.g., repo transactions with daily volumes regularly in excess of $700 billion).

Ultimately, Chairman Clayton observed that a lot of progress has been made in the transition from LIBOR to SOFR. Markets have already seen SOFR-based debt issuances, as well as developments in the SOFR swaps and futures markets. However, before settling into SOFR as the new benchmark, Chairman Clayton believes that more work needs to be done to development a SOFR term structure that will facilitate the transition from term-based LIBOR rates.

Good Day. DR2

]]>CFTC Chairman and Market Participants Weigh in on the Transition to SOFRhttps://www.derivativesandreporeport.com/2018/12/cftc-chairman-and-market-participants-weigh-in-on-the-transition-to-sofr/
Mon, 10 Dec 2018 20:58:55 +0000https://www.derivativesandreporeport.com/?p=2894Continue Reading]]>On November 29, 2018, in remarks before the 2018 Financial Stability Conference in Washington, D.C., Chairman J. Christopher Giancarlo of the U.S. Commodity Futures Trading Commission (“CFTC”) supported the adoption of the Secured Overnight Financing Rate (“SOFR”) as the new benchmark for short-term unsecured interest rates. SOFR is currently produced by the Federal Reserve Bank of New York (“New York Fed”) and is based on transactions in the repurchase agreement transaction (“repo”) markets. Chairman Giancarlo’s statements and support of SOFR come on the heels of a series of market and regulatory developments relating to benchmark reform.

Since 2017, regulators and financial market industry leaders have been working to design alternative interest rate benchmarks. Significantly, in June 2017, the Alternative Reference Rates Committee (“ARRC”), an organization convened by the Federal Reserve Board (“FRB”) and the New York Fed, selected a broad repo rate as its preferred alternative reference rate. In choosing a broad repo rate, ARRC considered factors including the depth of the underlying market and its likely robustness over time; the rate’s usefulness to market participants; and whether the rate’s construction, governance, and accountability would be consistent with the IOSCO Principles for Financial Benchmarks.

Then, as we previously noted, the Treasury Department proposed a new rule (the “Proposed Rule”) in July 2018 for data collection of centrally cleared repos that would support and enhance the calculation of both SOFR and the Broad General Collateral Rate (“BGCR”). The Proposed Rule itself would require the submission of information by central counterparties with average daily total open repo commitments of at least $50 billion. In response, the Securities Industry and Financial Markets Association (“SIFMA”) submitted a comment letter in September 2018 arguing for the Proposed Rule. SIFMA believes that the Proposed Rule’s data collection will contribute to the overall robustness of SOFR and will aid SOFR’s viability as the alternative reference rate.

In his November 2018 remarks, Chairman Giancarlo advocated for the adoption of SOFR as the appropriate replacement for LIBOR and added that the CFTC is already working on the transition. For the CFTC’s part, the Commission’s staff is working with ARRC to support an efficient transition to SOFR by addressing any issues created by the CFTC’s current rules. In addition, the CFTC’s Market Risk Advisory Committee led by Commissioner Rostin Behnam is evaluating the issues related to the transition from LIBOR to SOFR. Chairman Giancarlo concluded his remarks by imploring market participants and firms to begin transacting in SOFR derivatives immediately, or else the development of a robust-term rate will be a challenge.

The Adviser offered nine repo facilities involving loans guaranteed by various government entities. Under an agreement with First Farmers Financial (“FFF”), FFF purportedly pledged loans guaranteed by the U.S. Department of Agriculture (“USDA”) as collateral for the repo. However, the loans turned out to be fraudulent, and FFF and its corporate officers exhibited a number of red flags along the way, including providing falsified financial statements from a fake auditor.

The SEC found that the Adviser violated various provisions of the IAA and its rules by harming its advisory clients, which included a registered investment company, in two primary ways. First, the SEC found that Adviser failed to pursue the truth about FFF’s repos in the wake of missing audited financial statements and warnings by Adviser employees and a private investigator. And second, Adviser failed to adequately resource its compliance department and did not have or follow compliance policies and procedures that could have prevented the FFF issues in the first place.

Under the SEC’s enforcement order, Adviser must pay a civil monetary penalty of $400,000. The SEC’s enforcement order against Adviser can be found here.

Good Day. DR2.

]]>Treasury Department Proposes a New Rule for Data Collection of Centrally Cleared Repo Transactionshttps://www.derivativesandreporeport.com/2018/08/treasury-department-proposes-a-new-rule-for-data-collection-of-centrally-cleared-repo-transactions/
Mon, 27 Aug 2018 16:39:50 +0000https://www.derivativesandreporeport.com/?p=2806Continue Reading]]>Last month, on July 10, 2018, the Office of Financial Research (“OFR”), an agency of the U.S. Department of the Treasury, proposed a new rule that would require collection of data with respect to centrally cleared repurchase agreement transactions (“repos”) (the “Proposed Rule”). The proposal stems from a multi-year effort by the Financial Stability Oversight Council (“FSOC”) to expand and make permanent the collection of repo data.

The Proposed Rule seeks to enhance the ability of FSOC and OFR to identify and monitor risks to financial stability, as well as support the calculation of certain reference rates for repos. Particularly for the calculation of certain reference rates, OFR asserted that the new data from the Proposed Rule would support and enhance the calculation of both the Secured Overnight Financing Rate (“SOFR”) and the Broad General Collateral Rate (“BGCR”).

The Proposed Rule itself would require the submission of information by central counterparties with average daily total open repo commitments of at least $50 billion. The proposed collection has three schedules: the first covers details on general collateral trades, the second covers details on the securities used to collateralize net positions in general collateral repo, and the third covers specific-security trades. Additionally, the Proposed Rule would use the Federal Reserve Board as collection agent for the data, with the data submitted directly to the Federal Reserve Bank of New York.

Currently, only two services of the Fixed Income Clearing Corporation (“FICC”) would meet the Proposed Rule’s qualifications: the GCF Repo Service (a general collateral repo service) and the DVP Service (a specific-security repo service). However, OFR asserted that other firms could meet the eligibility criteria for reporting in the future.

]]>The Fed’s Repo Rates Are Herehttps://www.derivativesandreporeport.com/2018/04/the-feds-repo-rates-are-here/
Mon, 16 Apr 2018 19:17:35 +0000https://www.derivativesandreporeport.com/?p=2780Continue Reading]]>On April 3, 2018 the Federal Reserve Bank of New York (“Fed”) started publishing its three repo rates: the Secured Overnight Financing Rate (SOFR), the Broad General Collateral Rate (BGCR) and the Tri-Party General Collateral Rate (TGCR). For an overview of differences between the composition of each of the rates please refer to our prior post.

Previously, in March, the Fed released “a time series of the volume-weighted mean rate of the primary dealer’s overnight Treasury general collateral repo activity. . .” which it calculated from its surveys of the primary dealers. The Fed also released indicative historical rates for the SOFR rate going back to August 2014. It also indicated it was going to investigate providing a longer historical period for the SOFR rate. The historical data appears to be a response to comments received during the request for comment phase where three commenters requested historical data for SOFR in order to assist market participants in structuring margin requirements on derivative instruments that reference SOFR and assist in comparisons to other benchmarks.

On April 10th, the Fed released a statement stating that it had received feedback that the bilateral repo volumes included in the SOFR rate appeared higher than expected. The Fed stated that it was looking into the bilateral repo data received from the data provider and accessing whether or not there is any impact on the rate or volumes. No previously published rates will be revised as part of the review but if a change is made on a going forward basis revised historical data will be made available according to the statement. The rates and volume on April 9th were: 1.75%/833B for SOFR; 1.70%/341B for BGCR and 1.70/330 for TGCR. Therefore, it appears that certain market participants are questioning the extent of the volume gap between SOFR and the two other rates. Stay tuned for more on this issue!

Update (04.16.2018): The Fed posted a notice today stating that, following a review, the SOFR rate’s volume was too high due to “forward-settling overnight Treasury repo transactions” being inadvertently included in the rate. Accordingly, the SOFR rate going forward will be adjusted to exclude such forward-settling repo transactions. The Fed released data on how the SOFR rate would have been calculated had it excluded such transactions from April 2 to April 12th. Lastly, the Fed undertook to update the historical rate figures it previously provided on its website for SOFR.

Good Day. DR2

]]>Tri-Party Repo Data: October 2017https://www.derivativesandreporeport.com/2017/11/tri-party-repo-data-october-2017/
Mon, 20 Nov 2017 19:20:13 +0000https://www.derivativesandreporeport.com/?p=2749Continue Reading]]>The Federal Reserve Bank of New York (FRBNY) released the monthly statistics of the U.S. tri-party repo market for October 2017.

Tri-party repo statistics are available on a consolidated basis through the FRBNY’s tri-party repo interactive tool (available here) and master excel data file (current version here and click on Downloads).

As of October 11, 2017, total collateral in the U.S. tri-party repo market decreased by $8.7 billion to $1.87 trillion. As of October 11, 2017, total collateral has remained above the $1.70 trillion level for the last 13 months, since rising to that level in October 2016 for the first time since 2013, and has remained above the $1.80 trillion level for the last six months. As of October 2017, U.S. Treasuries excluding Strips collateral was $923.31 billion, making it the second consecutive month above the $900 billion level. International Securities continued its upward trend to $6.45 billion, the first time over the $6 billion level since January 2014.

Median margin levels largely remained stable. The median margin level increased for Agency Collateralized Mortgage Obligations from 3% to 4%, and decreased for ABS Non-Investment Grade from 15% to 10% and for Municipality Debt, from 5% to 3%.

The following is intended to be a Buy Side guide to the Final Rule (the Buy Side will generally be referred to as the “counterparty” in this post):

What Is the Purpose of the Final Rule?

The overarching goal of the Final Rule is to:

Facilitate the orderly resolution of global systematically important banking organizations (GSIBs) by limiting the ability of trading counterparties to terminate their contracts with the GSIB immediately upon entry of the GSIB or one of its affiliates into a resolution regime;

In order to achieve the overarching goal the Final Rule seeks to:

Reduce the risk that a foreign court would disregard statutory provisions (e.g. orderly liquidation authority under Dodd Frank or FDIC receivership) that would stay the rights of a counterparty to a failed GSIB to terminate their contracts with the GSIB immediately upon the entry of the GSIB into a special resolution framework for failed financial firms.

Facilitate the resolution of a large financial entity under the U.S. Bankruptcy Code by ensuring that a counterparty to a solvent affiliate of the failed entity cannot trigger default rights under the contract solely based upon failed entity’s enter into resolution (e.g. cross-default to failed entity).

What type of financial contracts are subject to the Final Rule?

The restrictions are imposed on “qualified financial contracts” (QFCs), which include derivative, repo, reverse repo, securities lending/borrowing contracts, commodity contracts and forward agreements entered into with a “covered entity”.

Advisory contracts with retail advisory customers if only transfer restrictions are those imposed by Investment Advisers Act of 1940;

Warrants evidencing a right to subscribe or to otherwise acquire a security of a covered entity or its affiliate; and

Any other contract exempted by the Federal Reserve Board upon request for an order.

Which of my dealers are Subject to the Rule?

The Final Rule applies to trades with GSIBs and their subsidiaries and with the U.S. operations of global systemically important foreign banking organizations and their U.S. subsidiaries, U.S. branches and U.S. agencies (“Foreign GSIBs” and collectively “Covered Entities”).[1]

As of the date of the Final Rule GSIBs consisted of the following: Bank of America Corporation, The Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley, Inc., State Street Corporation and Wells Fargo & Company.

The Final Rule would require a covered QFC with a covered entity to provide in the contract: 1. that the transfer of the QFC from the covered entity to a transferee would be effective to the same extent it would be under the U.S. special resolution regimes (FDI Act and Title II of Dodd Frank) if the covered QFC were governed by the laws of the United States; 2. that the QFC’s default rights that could be exercised by the counterparty against a covered entity could be exercised to no greater extent than they could be exercised under the U.S. special resolution regimes if the covered QFC were governed by the laws of the United States.

The Final Rule would also prohibit a QFC from containing a default provision that is tied, directly or indirectly, to an affiliate of the direct party to the QFC becoming the subject to receivership, insolvency, liquidation, resolution, or similar proceeding. The Final Rule release notes that the use of “indirectly” was purposeful and could capture a credit rating downgrade default that is a result of the affiliate going into a resolution regime. Additionally, a QFC cannot prohibit the transfer of any credit enhancement provided by an affiliate to the direct party to a transferee upon the entry into resolution of an affiliate of the direct party unless the transfer would result in the counterparty being the beneficiary of a credit enhancement that is violation of a law applicable to counterparty.

A primary purpose for these restrictions is to facilitate the resolution of a GSIB under the U.S. Bankruptcy Code (e.g. outside of Title II resolution regime). For example, in a single point of entry (SPOE) resolution, the GSIB’s parent entity would enter resolution. If such entry led to the mass exercise of cross-default provisions by the subsidiaries’ QFC counterparties then the subsidiaries to the parent could themselves experience financial distress as a result of the cross defaults. The release notes that these restrictions does not affect a counterparty’s rights under the U.S. Bankruptcy Code and accordingly a counterparty to a covered entity that has entered into bankruptcy proceedings would be able to exercise default rights to the extent permitted under the applicable bankruptcy safe harbors.

Will I Need to Amend My Trading Documentation?

Likely yes, if you are a counterparty that is trading a covered QFC with a covered entity. However, note the significant exceptions outlined below.

The Final Rule states that adherence to the ISDA 2015 Universal Resolution Stay Protocol by the parties to a covered QFC would constitute compliance with the contract requirements of the Final Rule. It notes that such parties can adhere to the Protocol or they can incorporate the terms of the protocol into their contract(s). The Final Rule also states that parties can utilize the “U.S. protocol” which is defined as the Universal Protocol with some permitted changes to the attachment to the Universal Protocol.

A covered QFC is not required to be conformed to the contractual requirements of the Final Rule if:

Each party to the QFC, other than the covered entity, is incorporated, organized or has principal place of business in the United States; and

The covered QFC explicitly provides that it is governed by the laws of the United States or a state of the United States; and

The covered QFC does not explicitly provide that one of both of the U.S. special resolution regimes is excluded from the laws governing the QFC.

Implications: Accordingly, a U.S. domiciled mutual fund with a repo or ISDA agreement with a US GSIB that is governed by U.S. law and does not explicitly exclude a U.S. special resolution regime would not have to be amended.

Treatment of Overnight Repo: In response to a request from a commenter that overnight repo be specifically excluded from the scope of a covered QFC the release states: “Although the final rule does not exempt overnight repo transactions, the final rule may have limited if any effect on such transactions. As described below, the final rule provides a number of exemptions that may apply to overnight repo and similar transactions. Moreover, the restrictions on default rights . . do not apply to any right under a contract that allows a party to terminate the contract on demand or at its option at as specified time, or from time to time, without the need to show cause. Therefore, [Final Rule section] does not restrict the ability of QFCs, including overnight repos, to terminate at the end of the term of the contract.” (See, Footnote 110).

The Final Rule also expressly permits certain contractual provisions (e.g. certain default rights after stay period). These will be explored in a future post.

Good Day. DR2.

Footnotes

[1] U.S. national banks, Federal savings associations, Federal branches, Federal agencies are technically not included in the definition of “covered entity” under the Final Rule because they will be covered by a separate but largely identical rule passed by the applicable banking regulators. The OCC is expected to issue a substantially identical rule that would apply to covered banks.

]]>Tri-Party Repo Data: September 2017https://www.derivativesandreporeport.com/2017/10/tri-party-repo-data-september-2017/
Mon, 16 Oct 2017 20:46:27 +0000https://www.derivativesandreporeport.com/?p=2728Continue Reading]]>The Federal Reserve Bank of New York (FRBNY) released the monthly statistics of the U.S. tri-party repo market for September 2017.

Tri-party repo statistics are available on a consolidated basis through the FRBNY’s tri-party repo interactive tool (available here) and master excel data file (current version here).

As of September 12, 2017, total collateral in the U.S. tri-party repo market increased by $56 billion to a new multi-year high of $1.88 trillion. As of September 12, 2017, total collateral has remained above the $1.70 trillion level for the last 12 months, since rising to that level in October 2016 for the first time since 2013, and has remained above the $1.80 trillion level for the last five months. As of September 2017, U.S. Treasuries excluding Strips collateral was $928.86 billion, making it the 12th straight month above the $800 billion level.

Other than International Securities (which decreased from 3% to 2%), median margin levels remained stable.

Good Day. DR2.

]]>Tri-Party Repo Data: Summary for April 2017 to August 2017https://www.derivativesandreporeport.com/2017/09/tri-party-repo-data-summary-for-april-2017-to-august-2017/
Tue, 12 Sep 2017 17:18:27 +0000https://www.derivativesandreporeport.com/?p=2704Continue Reading]]>The Federal Reserve Bank of New York (FRBNY) continues to track and release monthly statistics of the U.S. tri-party repo market. This post concerns the April 2017 through August 2017 statistics (the “Five-Month Period”).

In March 2017, the FRBNY discontinued publishing the PDF and excel files containing single month statistics to which we have ordinarily provided a hyperlink. Instead, tri-party repo statistics will only be available on a consolidated basis through the FRBNY’s tri-party repo interactive tool (available here) and master excel data file (current version here).

Total collateral in the U.S. tri-party repo market decreased to just above 1.72 trillion for April 2017 before rising in May 2017 to $1.84 trillion, and then in June 2017 to a multi-year high of $1.87 trillion. It then saw a decrease in July and August 2017, ending at $1.82 trillion. As of August 9, 2017, total collateral has remained above the $1.70 trillion level for the last 11 months, since rising to that level in October 2016 for the first time since 2013, and has remained above the $1.80 trillion level for the last four months. As of June 2017, U.S. Treasuries excluding Strips collateral was $983.80 billion; it then decreased to $925.99 billion in July 2017 and to $887.51 billion in August 2017. However, it was still the 11th straight month above the $800 billion level. During the Five-Month Period, Equities collateral hovered around the $130 billion level, then rose to almost $139 billion in July 2017, and ended at $141.6 billion in August 2017. In July 2017, Agency Debentures and Strips hit an all-time low of $34.79 billion, but increased in August 2017 to $40.48 billion.

Other than U.S. Agency CMOs (which fluctuated between 3% and 4%), median margin levels for the Fedwire-eligible collateral types were unchanged during the Five-Month Period. In April 2017, the median margin level for Private Label, Non-Investment Grade Collateralized Mortgage Obligations collateral increased from 8% to 9%, dropped back to 8% in May and June 2017, fell to 5% in July 2017, and ended at 3% in August 2017. The median margin level for CMO Private Label Investment Grade collateral decreased 2 percentage points to 5% during the Five-Month Period.